A focus on bank lending standards and the upside for our senior secured lending strategy

  • Over the last week we have seen key supporting data points for national housing prices and indications investors are re-joining owner occupiers as new purchasers.
  • The ongoing positive momentum in value for our loan collateral further enhances our perspective that an 8-10% return for senior secured loans continues to be one of the best risk adjusted returns in the investing world.
  • Higher asset values and ongoing investors support, whilst good news for our seasoned loan book, require some consideration of underlying values of new loans written.
  • The RBA has historically raised concerns that low interest rates and rapidly rising house prices could lead to a deterioration in lending standards, a key negative for financial stability and consumer balance sheets. In this context two key data points on the radar are:
    1. House prices: The CoreLogic national Home Value Index rose a further 2.2% in May to be up 10.6% for the year. The rise in housing markets have been broad-based across geography, housing types, and valuation segments, but two trends that were evident throughout 2020 have begun to “normalise”. These include the more recent outperformance in capital city home prices (particularly the large capital cities) compared to regional areas which previously benefited from demographic and COVID-19 related demand shift, as well as the relative outperformance of the most expensive end of the market.
    2. Housing credit growth, including from investors: Housing credit grew 0.5% in April, comprising a 0.6% increase in owner-occupier housing credit and a 0.4% increase in investor housing credit.
  • The RBA comments about lending standards aren’t new, but the recent strong uptick in investor credit growth to 0.4% has now raised some eyebrows. The last time investor housing credit growth was at these levels we saw APRA announce its “Further Measures to Reinforce Sound Residential Mortgage Lending Practices” (March 2017). Those measures included limiting the proportion of new interest-only loans to 30% and limiting investor lending growth to 10%.
  • We hate to say it, but this time around we think “things will be different in driving a policy response” and any new measures to maintain lending standards would be introduced much more “gently”. Three key reasons for this view are:
    1. Despite the recent uptick in credit growth, the annual increase remains low by historical standards at 4.4% – and only 1.1% for investor credit growth.
    2. There is little evidence to suggest any significant increase in higher risk (high LVR) loans
    3. In a post-Banking Royal Commission environment, banks will be less willing to take on higher risk loans – maintaining a higher level of “self-regulation” in respect of lending standards.
  • From a historical perspective, the previously imposed measures achieved their objective – an increased focus on improving new mortgage lending quality and a moderation in the growth in investor lending. They also contributed to a financing void which enabled the growth in attractive investment opportunities for the Partners Fund.
  • In today’s environment, we see the RBA’s dilemma as something much more positive. Strong demand for credit and the focus on lending standards will provide an increasing level of investment opportunities offering attractive rates of return, while low interest rates and stable/rising asset prices will ensure valuations remain well supported. Combined, it means the Partners Fund and Agriculture Credit Fund will be in a position to continue providing attractive, risk-adjusted returns for our investors.